In an open market economy, suppose government is planning to set a real wage floor permanently which is ten percent higher than the market-clearing real wage rate

The government is planning to set a real wage floor permanently which is ten percentage higher than market clearing real wage. rate. Employed people pay social security tax on their labor incomes, revenues from which is distributed to unemployed people as unemployed benefits. Unemployed people fully spend their income for consumption while employed people save a fraction of their income.

Wage floor increases 10% greater than market real wage rate. It increases the real wage rate of labor. Increase in real wage rate also increases the nominal wage rate. Higher wage rate increases the cost of production of firms. In order to offset the higher cost of production, firm increase the price of commodities. It will increase the general price level in long run and very long run. Due to higher cost of production firm will reduce labor demand. It increases unemployment in long run.

Higher price level increases money supply in the economy. It depreciates the domestic currency and nominal exchange rate rises . It also causes real exchange rate to rise. Because higher price level increase the price of goods and services in domestic economy in relative to foreign goods and services. Then export become costlier and import become cheaper. As a result real exchange rate will rise

Higher money supply reduces interest rate and causes increase investment level due to fall in cost of borrowing. Increase in wage floor causes real rental rate to rise